Advantages of introducing Islamic banking system in India

By Pamkhuila Shaiza on July 22, 2016
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As seen in the previous context, an announcement of the instituting ‘Islamic banking system’ by the Indian government has garnered nation-wide interest in recent months. The article primarily focusses on socio-economic development and promoting egalitarianism or Islamic banking in India.

A big part of India needs Islamic banking

Indian financial banking has undergone various changes and the most recent one being the development of Islamic banks. After 40 years of nationalisation of banks, more than 40% of Indians do not have access to the formal banking system. The Sachar Committee has been studying the socio-economic conditions of Muslims for a while. According to them a big section of the Muslim population does not have access to banking services (Fasih 2012). Besides the fact that it caters to the needs of the Muslim communities, Islamic banking also shows that the government is willing to show concern for the people. Islamic financial banking will help in achieving growth and development to boost the Indian banking sector (Padanna 2014).

Advantages of introducing Islamic banking in India

The Islamic banking system will ensure the participation of Indians living abroad in the banking and financial systems. This will create an ethical finance-sharing approach where the poor will benefit the most. Another benefit of India setting up non-interest-based Islamic banking is that it will attract many Middle-Eastern investors, bankers, and businessmen. Higher investment will boost the Indian financial backbone and the infrastructure development of the country (Padanna 2014). Islamic financial banking also promotes Indian Constitutional Goals (Rahman 2009). The three main pillars of the Indian Constitution; the Preamble, the Fundamental Rights and the Directive Principles of the State Policy (Directives), advocate for an egalitarian society. Therefore setting up such a financial system will only strengthen India towards greater democracy.

The system will unequivocally develop the deplorable condition of the poor and the marginalised group of the society. The non-availability of an interest-free banking system has always posed issues to the lower rung of society. This interest-free banking will prove otherwise for the disadvantaged group.

The Islamic system of banking shows promising advantages

In India, the scope of Islamic banking is very wide and it can grow along with other conventional banks. As a result, this will change the structure of the Islamic Financial Institutions operating in India. These financial institutes are neither in composition nor homogenous in nature and they, therefore, require one rule under the Islamic banking system. There are four main types of Islamic Financial Institutions in India namely:

  1. The Financial Associations of Persons, which are not registered under any Islamic Financial Institutes;
  2. Muslim Funds or Islamic Welfare Societies, which are either registered under the Societies Act or the Trust Act;
  3. Islamic Cooperative Credit Societies, which are registered with the larger registrar of cooperative societies;
  4. The Islamic investment companies, which is registered under the Companies Act (Bagsiraj 2002).

The onset of Islamic Banking is going to change this financial structure of the Islamic financial structure in terms of scope and possibilities (Khan & Hussin 2013). Setting up Islamic banking will be advantageous for India owing to its strong Muslim demographic component. India is the third country in Asia with the largest Muslim population after Indonesia and Pakistan. Muslims account for more than 14.6% of the Indian population. A big population of Muslims in India is highly supportive of the introduction of the Islamic banking system and 80% of them are set to deposit or invest. As a result, 67% of them are willing to borrow from financial banking institutions (Rahman 2009).

Islamic banking has a good scope in the Indian economy

Islamic banks across the world are unaffected by major world financial crisis due to the ethics embedded in their systems. Hence, many non-Muslim countries and communities are turning to the Islamic banking system (Rahman 2009). India aims for equitable distribution of wealth and contribution and growth of GDP. Islamic bank can help in this equitable distribution of income by encouraging equity by promoting the concentration of wealth (Fasih 2012).

The Sachar Committee report shows that Islamic banking will help the Muslims towards inclusive growth.  Since interest-free Islamic banking can help curb inflation the whole system is useful for the growth of the Indian economy. Many of the small and middle scale industries in India suffers under the Interest-based conventional financial system. RBI reported a decline in small and medium enterprise’s credit from 15.1% in 1990-91 to 6.5% in 2006-2007 (Fasih 2012). Islamic banking with an interest-free system will smoothen their flow of business and financial credit.

Challenges in including a new banking system

Sections like section 5 (b) and (c) of the Banking Regulation Act, 1949 does not allow investment on a Profit Loss Sharing basis, which is the very basis of Islamic banking (Rahman 2009). Similarly section 21 of the Banking Regulation Act, 1949 also requires the payment of interest for investment, which is against the Sharia system. In order to form a more egalitarian society, there is always the necessity to have such facilities as the Islamic banking system, since the present banking system is not conducive to all the needs of a large population.



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